Bitcoin boom: 'breakthrough moment' or billion-dollar bubble?

As the financial system in parts of the world crumbles, the decentralised digital currency Bitcoin has rocketed to a market capitalisation of almost $1.2 billion in what some believe is a sign the boom will soon turn to bust.

Bitcoin is an attempt to create a decentralised, crypto currency with no governments or central banks in control (see video). Transactions can be virtually anonymous, and the currency can be bought and sold at online exchanges.

One bitcoin is at the time of writing worth $A110 or $US115 - up from around $US50 in mid-March and below $US15 in January. There are almost 11 million bitcoins in circulation.

There have been reports that Europeans have been ploughing money into bitcoins after losing faith in governments and financial institutions - highlighted by the recent banking crisis in Cyprus - and the unstable euro.

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HSBC chief economist Paul Bloxham likens it to the recent increase in the value of gold. “As people lose faith in paper money ... we see a shift towards other sorts of assets,” he said.

Wall Street analyst Nick Colas, of the ConvergEx Group, said in a research note that Bitcoin was having its “breakthrough moment” but The Economist sees signs of a bubble, arguing new users are buying bitcoins as an investment rather than a means of exchange.

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While it gained popularity as the default currency for underground drug marketplace Silk Road, legitimate web-based firms such as Reddit, WordPress, Expensify, Kim Dotcom's Mega and Australian online retailer Patcht have begun offering bitcoin as a payment option.

One start-up claiming to have created the first Bitcoin ATM says it has received orders for over 300 machines in 30 countries.

BusinessWeek wondered whether Bitcoin may be the world's last economic safe haven - a big call considering the currency's turbulent history, which has seen the value rise and then crash to less than $US2 after several bitcoin exchanges and digital wallets were breached by hackers in 2011.

Patcht.com founder Simon Rodwell, based in Sydney, said he made the decision to accept bitcoins after frustrations dealing with banks, payment gateways and credit card providers.

He admitted he was “taking a gamble” on the fluctuating price but said to reduce risk his prices in bitcoins were derived by taking the current AUD-BTC exchange rate from BCChanger.com and adding a 5 per cent margin. So far, given the soaring price, margins on his few bitcoin sales had been “particularly high”.

“People currently see them [bitcoins] more as a commodity rather than a currency but I believe that will change over the coming year,” said Rodwell.

Australian beef delivery company honestbeef says it has been accepting bitcoins since 2011.

Colas said: “If central banks and regulators actually ran their monetary policies to maintain public confidence in the value of their currency, bitcoin wouldn't have a chance.”

With bitcoins there is no need to trust intermediary institutions to maintain the value of the currency, facilitate trades or store deposits on people's behalf. Payments can be made direct via peer-to-peer.

Instead of being issued by banks, bitcoins are “mined” in batches using PC software by those with access to huge amounts of computing power. The computers churn through complex mathematical puzzles, the difficulty of which ensures that coins are issued at a steady rate. Regular laptops can churn through the calculations for years without earning one coin, so most users buy bitcoins from online exchanges.

The number of bitcoins in circulation has been preprogrammed to grow at a slow rate, with issuance ceasing altogether in 2140.

The largest bitcoin exchange is Tokyo-based Mt. Gox, which reportedly processes around $US6 million worth of bitcoin trades per day.

The first Bitcoin hedge fund, Exante, launched in Malta in March, while in the US the Silicon Valley Bank recently partnered with Mt. Gox and Coinlab, agreeing to hold bitcoin deposits for US customers.

Reuters last year reported it had seen documents showing workers at Morgan Stanley and Goldman Sachs in London and New York were visiting online Bitcoin exchanges as often as 30 times a day.

Regulators are starting to pay attention, with the US Treasury Financial Crimes Enforcement Network on March 18 declaring that some Bitcoin businesses must register with government and abide by regulations.

For instance bitcoin exchanges would have to comply with similar rules to a traditional foreign currency exchange, such as verifying the identity of those making an exchange.

Some believe regulations will add legitimacy to the digital currency but the Bitcoin Foundation believes the regulator is over-reaching, arguing new rules must go “through proper rulemaking proceedings and not by fiat”.

A report published in October last year by the European Central Bank found virtual currencies like bitcoins did not pose a risk to financial stability because they had only a limited connection with the real economy, but it warned of the potential for them to be used by criminals, fraudsters and money launderers.